A number of community bankers are cautiously optimistic about their ability to take advantage of a recent spike in longer-term bond yields, though doing so will require time and patience.
The 10-year Treasury yield hit 2.5% last week its highest level so far this year after plunging to a two-year low of 1.68% in early February, and the spread between two- and five-year bonds has widened. (The yield for 10-year bonds has settled some since, dropping to 2.32% on Tuesday after the Federal Reserve Board said it plans to keep interest rates at near-zero levels for the immediate future.)
A steeper yield curve is a generally a boon for the industry, helping boost net interest margins, but it also creates risks for banks with large securities books skewed toward longer durations. Still, bankers note that it will take time for any benefits, or risks, to find their way into the income statement.
"It takes us about two years before we really start seeing" gains from higher rates, David Zalman, chairman and chief executive at the $21.6 billion-asset Prosperity Bancshares in Houston. "We'll get there, but we'll get there slowly."
A mix of global economic factors has contributed to the steepening yield curve, including a sell-off in the German bond market, industry experts said.
"The yield curve has been steepening as a global event" said Fred Cannon, global director of research at Keefe, Bruyette & Woods, adding that it's "hard to say exactly" what's causing an increase in yields for longer-term bonds.
A steeper yield curve should be viewed positively by bankers with loans and securities with shorter-term durations, industry experts said.
"The pros in the long term are good," Zalman said. "Higher rates generally mean a bigger net interest margin."
Still, there are tradeoffs whenever yields and rates move.
A rise in longer-term rates would likely put a dent in mortgage-related fees as demand for refinancing declines. Several community banks saw a surge in those fees during the first quarter because of a dip in rates. (The average rate on 30-year loan recently rose to 4% the first time since early November, according to Freddie Mac.)
An improving economy, however, should help banks make more loans for home purchases, Cannon said.
Higher bond yields could also put pressure on securities holdings.
"It's really how long-dated the portfolios are that are of most concern," Cannon said. Rising rates "can have an effect on the state of capital positions when you have longer-dated portfolios."
Prosperity, along with several other lenders focused on the oil industry, holds about half of its earning assets in securities, Cannon's team wrote in a June 12 note to clients. The company's securities book has an average duration of 3.9 years, Zalman said. (Industry experts said that banks, on average, have a mean duration of four years.)
Zalman said Prosperity has a lot of excess liquidity, compared to the size of its loan portfolio, noting that the company's loan-to-deposit ratio was close to 50% at March 31. That prompts a bank to find other ways to put deposits to work, which often leads to increased investment in securities.
"We're different than a bank that's 85% loans," Zalman said.
A pair of banks that focus on lending to technology firms had the highest percentage of securities, as a function of assets, among the banks covered by KBW. At March 31, securities accounted for roughly 58% of the earning assets at SVB Financial in Santa Clara, Calif., and 54% of the earning assets at Square 1 Financial in Durham, N.C.
Square 1 agreed in March to sell itself to PacWest Bancorp in Los Angeles. PacWest is in need of low-cost funding; its loan-to-deposit ratio stood at 103% at March 31.
High-quality deposits at SVB and Square 1 "significantly outstrip their loan balances," creating opportunities to invest, Aaron James Deer, an analyst at Sandler O'Neill, said. Neither bank will likely feel a meaningful impact from higher long-term yields because of the short duration of their securities books, Deer said.
SVB's investments have an average duration of 2.7 years, while Square 1's average duration is about 3 years, Deer said.
"Those banks are very asset sensitive," Deer said.